Queer optimism

The midcap bubble that refuses to burst

The highlight of the rally in the markets post the election results is clearly the wild run of mid-cap and small-cap stocks. These stocks are now back in focus, with the CNX Midcap 200 index hitting an all-time high on Thursday.

The index has now risen around 50 per cent since May 18, the day the rally began. Large cap stocks, represented by the Nifty, have risen by 32 per cent in the same period.

For perspective, this is not a case of mid caps catching up "" they had already done that long ago. Till date, the CNX Midcap index has risen over 200 per cent since its lows in 2003, compared to a less than 100 per cent rise for the Nifty.

In some cases, the rise in share price has been accompanied by an improvement in financial performance and prospects, coupled with better disclosure and corporate governance. Such stocks have even attracted foreign portfolio investment.

The problem really is with stocks that haven't seen any improvement either in financial prospects or corporate governance. Clearly, there isn't any case for a re-rating for such stocks, especially at a time when India Inc. is struggling with higher raw material and financial costs.

It's ironic, therefore, that small cap stocks (market cap The biggest gainers are mostly unheard of stocks that fit in the "speculative" grade. Also, in most cases where a higher valuation is justified because of better prospects, the gain has been huge so far, indicating that further upside is limited.

The main reason for this unprecedented rally in mid-cap and small-cap stocks is increased retail participation, which in turn has been fuelled by the reduction in short-term capital gains tax to 10 per cent (30 per cent).

Another reason could be the launch of a number of mid-cap mutual fund schemes this year, whose funds would have fuelled the mid cap rally even further. Whatever the cause, mid-cap and small-cap stock prices are now beyond reason.

Capex

Much has been said about the expected boom in capital spend. Hence, it's interesting to see whether the order books of companies in the capital goods industry corroborate these expectations.

Going by the order book data, it looks like the revival in investment spending is still patchy. For instance, strong growth is limited to few sectors suc as electricity generation and distribution.

In fact, it appears that investment in new roads, bridges and infrastructure development appears to have slowed down, as evidenced by the decline in the order book position of the engineering and construction company, Larsen & Toubro.

Senior management officials, while presenting last quarter's results, pointed out that L&T had experienced some delays from government bodies with regard to infrastructure projects.

However, there has been rapid growth in capital investment in the power sector. Private companies recently raised debt worth more than Rs 20,000 crore in a bid to set up projects with a generating capacity of around 6,000 MW and it appears this development has translated into improved demand for power equipment for leading suppliers.

In the case of ABB there has been a 19.6 per cent growth in its outstanding order book vis-a-vis the March quarter and for Bharat Heavy Electricals Limited the order book increased by 21.8 per cent.

ARPUs are bound to fall further

Average revenue per user (ARPU) of private GSM operators was maintained at Rs 402 in the September quarter, the same level as the June quarter. According to the COAI, it's for the first time in four years that there has been no decline or fall in ARPU for private GSM operators.

While this would come as a relief for private GSM operators, it's by no means a sign of things to come. At Rs 402, average spend on mobile phones amounts to a significant sum when seen as a proportion of per capita income, even if one were to leave out the population below the poverty line.

In developed markets, average spend on mobiles is a fraction of per capita income. Things will be no different in India if the market grows at the scorching pace it is expected to. New subscribers would be able to afford a much lower amount on cell phone expenses, and this would pull the average down.

It's not that cellular operators are unaware of this. Hence, the push towards new revenue streams such as data services. According to analysts, Bharti expects around 15 per cent of revenues to come from data services by FY06, while Reliance Infocomm is much more ambitious having targeted 40 per cent of its revenues from this source in two years.

As falling ARPUs are almost a given, it is imperative that telecom operators look at new revenue streams - not only to maintain growth, but also to protect margins.

With contributions from Mobis Philipose and Amriteshwar Mathur